SEC Ya Later: 3(c)(1) or 3(c)(7)

You're out here trying to raise your fund. Life is good. Then someone casually drops a “wait, aren’t you an investment company under the '40 Act?” and your soul leaves your body.

********THIS IS NOT FINANCIAL OR LEGAL ADVICE —- Frank barely passed Econ and thinks “qualified purchaser” sounds like a Costco membership******

👀 Wait… What is the Investment Company Act of 1940?

This law was created after the Great Depression-era chaos when pooled investment vehicles (think: early mutual funds) were acting like the Wild West. The Act puts heavy regulation on “investment companies” — i.e., companies primarily engaged in investing in securities.

But here's the catch for fund managers: VC and PE funds ARE investing in securities. So why aren’t they subject to the '40 Act?

🚧 Because… You Likely Rely on an Exemption.

The Investment Company Act is basically saying:

Most funds rely on one of two key exemptions:

1. Section 3(c)(1): The 100 Investor Limit

• You can have up to 100 beneficial owners (a.k.a. LPs).

• All must be accredited investors.

• No limit on AUM, just people.

• Common for small funds, family offices, and tight LP networks.

• But beware: if an LP is an entity (like another fund), each underlying investor might count toward your 100 cap. #CapTableCheck

2. Section 3(c)(7): Qualified Purchasers Only

• Unlimited number of investors.

• But they must be Qualified Purchasers (richer than your average accredited investor):

  • $5M in investments (for individuals)

  • $25M for institutions

• Gives you scale, but shrinks your eligible LP universe.

⚖️ TL;DR: 3(c)(1) = more people, less money. 3(c)(7) = fewer people, more money.

🧠 Tactical Takeaways for Fund Managers:

✅ Choose your exemption upfront.

• This affects your fundraising strategy, LP screening, and legal docs.

• It’s very hard (aka expensive and annoying) to switch exemptions mid-fund.

✅ Coordinate with your lawyers and fund admin to track beneficial ownership.

• That $10M LP who invested through an offshore trust and 3 sub-entities? Yeah, you might accidentally be at 103 investors.

✅ Don’t market like a public fund.

• No general solicitation or public advertising, especially under 3(c)(1).

• That means no TikTok ads like “Invest in my VC fund 💰✨.”

• Under 3(c)(7), you have a little more flexibility with "testing the waters," but still: get counsel.

💡 Strategy Mode: How to Use This To Your Advantage

1. Consider starting with 3(c)(1) for Fund I.

• Easier to find accredited investors than QPs.

• Cap table management is key — consider fund of funds and anchor LPs who can write larger checks to keep you under 100.

2. Graduate to 3(c)(7) for Fund II+.

• As you build a track record, you’ll attract more institutional and QP-level capital.

• Allows you to scale AUM without worrying about additional administrative cost per LP.

☠️ Mayhem Moments: What Happens if You Mess This Up?

• If you accidentally trip the Investment Company Act:

  • You could be deemed an unregistered investment company (a.k.a. illegal mutual fund vibes).

  • The SEC can unwind your fund.

  • LPs can sue.

  • You are now fundraising for your GoFundMe legal defense fund.

TLDR: Don’t go fancy pants on this one. If your lawyers are somewhat competent, just do what they tell you to do.

May your LPs be qualified, your investor count low, and your compliance airtight.

Til next time,
— Fund1 Frank
Currently counting my LPs like I’m in the IRS’s escape room.